Scandal - Market Crisis

Updated Nov.6

The current market crisis, widely acknowledged to be the worst since the Great Depression ($), has its roots firmly planted in the subprime mortgage crisis, which in turn was caused by unscrupulous lending by the mortgage industry, deceptive credit ratings, and years of deregulation and loose mortgage standards.

The mortgage crisis then spiraled into global proportions because the mortgage industry bundled its home loans into complex -- and often unregulated -- financial vehicles, which it sold to major banks across the country. When housing prices began to fall in 2006 and mortgage rates kept rising, the default rate on home loans skyrocketed. And the financial industry was left scrambling to cover those debts.

Many banks were surprised to learn the extent to which they had exposed themselves to risk because the credit-rating agencies had given these bundled loans their highest ratings, and the banks had purchased credit-default swaps, a type of unregulated insurance, to cover their bets. But the ratings turned out to be faulty, which some employees knew at the time, and the credit-default swaps ended up actually fueling the crisis.

In March, the crisis claimed the investment bank Bear Stearns, and the Federal Reserve provided financial backing to secure a merger with JPMorgan Chase. Countrywide -- the nation's largest mortgage lender -- was also felled after mounting losses from subprime investments forced a sale to Bank of America. Further, The Wall Street Journal and Portfolio reported that Countrywide CEO Angelo Mozilo had given preferential mortgages to VIPs, including two U.S. senators, and three states filed lawsuits ($) against the company for deceptive business practices.

In September, major banks and financial institutions began to falter in rapid succession, and the government scrambled to respond with the greatest market involvement ($) since the 1930s. Mounting financial troubles ($) at the government-sponsored mortgage giants Fannie Mae and Freddie Mac, which own or guarantee nearly half of all U.S. mortgages, forced the Treasury to bail them out on September 7.

Just a week later, Lehman Brothers, its books laden with subprime mortgages, filed for bankruptcy (the biggest in U.S. history), and Bank of America bought a floundering Merrill Lynch. On September 16, the Fed agreed to bail out the insurance behemoth AIG ($) for $85 billion. It later extended AIG's credit line to $143 billion after the company burned through most of the cash.

In early October, Congress authorized the Treasury to spend $700 billion to quell the crisis and thwart further bank failures. Two weeks later, the Treasury announced that it would use $250 billion of that to buy stakes in U.S. financial institutions in order to get them lending again. It began with the country's biggest banks, which were given little choice in the matter, and then moved on to smaller, regional banks.

The Treasury's plan has been widely criticized for not requiring the banks to lend. Instead, many banks have been using the money to gobble up weaker banks and pad the pockets of their stockholders and executives.

We're keeping a running tally of the banks getting bailout bucks.

Essential Reading (and Listening):

This American Life explains the subprime mortgage crisis in a broadcast called "The Giant Pool of Money."
The New York Times' Roger Lowenstein explains how the three biggest credit rating agencies gave many securities backed by subprime mortgages their highest rating when in fact they were poised for disaster. Bloomberg also has a great two-part series on this.
Portfolio broke the story about Countrywide's ‘Friends of Angelo' program, which gave preferential mortgages to Sens. Christopher Dodd and Kent Conrad, among other VIPs.
The Washington Post explains how years of weak regulation and lax oversight helped bring about the crisis at Fannie Mae and Freddie Mac.
The New York Times' financial columnist answers FAQs on the Wall Street crisis and the government's response.
The Wall Street Journal goes inside the AIG Bailout ($).
Two economists put the crisis on Wall Street in layman's terms.
A USA Today article explains how the Wall Street crisis will affect taxpayers, mortgage borrowers, retirement investors and others.

Essential Documents:

If you're looking for a quick, simple explanation of the subprime mortgage crisis, check out this stick-figure slideshow.
And here is a "Dummy's Guide to the Banking Crisis," along with a comprehensive timeline.
This Wall Street Journal chart compares the bailouts of Bear Stearns, Fannie Mae and Freddie Mac, and AIG.
ProPublica's graph compares past U.S. bailouts.
This New York Times graph shows the losses of major banks in the last year.
This Wall Street Journal chart compares 2008's 13 bank failures.